Fixed Indexed Annuities- Am I invested in the Market?

Have you ever heard someone say… “My financial adviser has me in some sort of index, but they reassured me that I can never lose money even if the market goes down!”

You may think to yourself…that sounds like a scam and I’m glad that guy is not my adviser.

The truth? This solution does exist and you’re not actually invested in the market and you can take part in market gains.  How’s that possible? It’s all because of the fixed indexed annuity.

So what is the Fixed Indexed Annuity and how does it work?

Fixed indexed annuities are offered by insurance companies. As of right now they are not considered securities since the principal is not invested in the market. They can be sold to you by someone with just an insurance license. If your principal was invested in the market it would be considered a security and only licensed financial advisers would be allow to sell this solution.

Just like a fixed annuity, your money is placed into the general account of the insurance company and you are guaranteed a rate of return. The rate of return is actually decided by you. You can choose an index and get a partial rate of return of what that index produces over the course of a year. Again the money is not actually invested in the index or the market.

Let’s look at an example to cement these ideas.

You have 100k to invest, but don’t want to be in the market and you want a rate of return that will beat the local bank’s CD offering of 2%.

Insurance Company A is offering:

  • Fixed Annuity- 5 year -3.90%
  • Fixed Indexed Annuity-5 Year- Tracking the S&P 500, Capped at 7%

So, which one do you choose and what does this actually mean.

The fixed annuity will pay you 3.90% for 5 years tax deferred. So in essence you’re getting $3900.00 each year for the next five years. Grand total $19,500. You take your money after 5 years ($119,500.00) in which the 19k is taxable as earned income.

Now the fixed indexed annuity is guaranteeing you 7% a year based on the performance of the S&P 500. So if the S&P does 5% you get 5% and if the S&P does 12% you get 7% because you are capped at 7%. If the S&P does 1 % for the year, you get 1%. So you can still get a higher rate of return, depending on the performance of the index.

So what happens if the market goes down? Let’s say that the S&P 500 does -1.2% for the year. Well, you’re not in the market so you don’t lose anything and you don’t gain anything. Why? Again, your money is not in the market, it remains in the general account of the insurance company.

With fixed indexed annuities there are different ways for an insurance company to credit your principal. These crediting strategies can be called cap rates, participation rates, point to point, 2 year points, and spreads. For the scope of this article we will only focus on cap rates, which was described in the example above. We will have another article on this in the future.

There is one final thought about fixed indexed annuities and crediting strategies that is really important. If you buy a 5 year fixed indexed annuity with a cap of 7% based on the S&P 500, after year one of the contract, the insurance company takes a snap shot of the index. On that snap shot date, your account is credited the interest of the S&P 500 performance. So if the S&P 500 did 7% your account is granted 7% or $7k. Your account value is now $107,000. That 107k is locked in. It can never go down from there.

Now in year 2 of the contract, the S&P does 3%, your account is credited 3% to the $107k. Your account value is now $110,210. Once again the amount is locked in. You’re account never goes down from there. The process continues until the contract expires.

Fixed indexed annuities are a great way to invest money by taking part in the market without actually being in the market. In the above example, you can always buy a fixed annuity along with a fixed indexed annuity, creating a balance. The fixed annuity portion can help secure at least 3% return when an index is only returning 1%. Again this is based on the above example and fictional. As always, do your research, ask questions, and feel free to reach out to us at CFE

Thanks for reading. Happy Investing!



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